Congratulations LSEers

Congratulations to everyone who received their results today for the MSc International Political Economy and MSc International Relations programmes at the London School of Economics. They are well deserved.

al-Qaeda video to influence US election?

As you knew they would...Drudge points to a Reuters report that an al-Qaeda video has been released calling for Bush and Republican party to be "humiliated" in next week's US election.

Many believe that the Bin Laden videotape released in the 2004 election's final week swayed some independent, undecided voters. Enough to put Bush over the top? Impossible to say. But key segments of the Ohio and Florida voting population likely responded to the video (for example- middle-class white mothers who came to be defined as 'security moms', or ex-military voters in Florida).

I seriously struggled over whether to post on this topic, lest I contribute in any way to the propaganda. But it is out there, and was pivotal to last presidential election, so I believe it is worth a comment. My primary motivation is to say this- come on America. Let's stay focused over these next 5 days, regardless who we vote for. The economy, financial crisis, Iraq, Afghanistan, health care, education, trade, foreign policy philosophy, our image abroad, the deficit- these are the issues we should be considering when walking into the voting booth. Let us not make the same mistake twice. Let us not allow bullshit propaganda to sway what is the most important election in generations.

The IMF is suddenly relevant again

Conditionality almost killed the IMF. The disastrous consequences of its conditional approach to the Asian financial crisis (the first lending phase, at least) not only justified many of the activist critiques that followed the Fund, they also resigned a generation of policymakers to fortify their countries from ever having to go cap in hand to the Fund again. The massive reserve accumulation of the past decade is a direct result of this apprehension. As recently as last fall, serious voices were questioning the relevance of the Fund in the 21st century, and many saw it heading the way of dodo.

Fast-forward 12 months, and the Fund is once again acting to stabilize emerging markets around the world. Iceland, Hungary, Belarus, Pakistan. All have lined up to meet IMF officials, with Iceland and Hungary agreeing to emergency packages, and Ukraine and Pakistan close to the same. Remarkably, Belarus has requested an assistance package just to be safe, and indicated a desire to liberalize (no arm twisting here). Belarus is a typical example of emerging market policymakers using IMF conditionality as a credible commitment mechanism to entrench policy reform (and its rapprochement with the West). There are even questions whether the Fund will have the resources to meet the certain increase in demand for its services over the coming months.

The IMF's ressurection is not without controversy (even that great bastion of free market orthodoxy, the Wall Street Journal, has expressed concern over the Fund's approach to Pakistan); specifically, whether the Fund will play the role of international credit union or policy reformer. The early indications are promising: the Fund has announced the creation of an emergency fund (max $100bn) to provide short-term financing assistance to emerging economies experiencing balance of payments crises. The emergency fund will be made available to "pre-approved" countries without any conditionality attached (in reality, a handful, with Argentina notably "pre-declined").

This is a welcome development, and points to a Fund that has learned from its past deficiencies. The Fund has no business dictating the policy reforms of countries experiencing temporary balance of payments crises. Assisting these well-run economies overcome their short-term BOP problems could help stem the kind of contagion that caused such havoc in the late 1990's. The Fund's approach to countries like Pakistan is more conditional (as it should be), and it remains to be seen what these structural reforms will look like. But in acting to stem the current financial crisis through rapid, unconditional assistance to otherwise healthy economies, the Fund has taken a major step forward. It should be applauded.

Rethinking the Fiscal Stimulus Approach

We've been writing regularly about the possibility of an increase in discretionary government spending to offset the decrease in consumer spending over the next few months: the fiscal stimulus packages under discussion in the US, UK and elsewhere. Broadly speaking, I think both Rory and I lean in favour of such measures during serious economic downturns, as long as they are targeted appropriately.

But here's a refreshing dose of perspective: a set of IMF graphs that illustrate the cumulative impact of tax cuts & fiscal spending over the course of 4 and 12 months in various OECD countries. Of the economies analyzed, only Australia seems to gain any significant benefit from fiscal spending after a year has passed. Most other countries, including Canada, the UK and US, get negligible or negative effects from greater fiscal spending.

Why? Leakage. OECD economies are open and thus liable to see any stimulus effects quietly disappear, leaving behind a deficit that burdens future economic performance. This makes the whole notion of aggressive anti-recession spending problematic. Interestingly, the IMF findings show a roughly similar pattern for tax cuts - the "go-to" policy for the opposite end of the ideological spectrum.

(Updated thought: could it be that 12 months is not enough time to see return on fiscal spending targeted towards more long-term projects like infrastructure?)

So where does that leave policymakers in times of crisis? Stephen Gordon suggests more defensive measures: beefing up the social safety net, particularly for the soon-to-be unemployed. Robert Reich, a former US Secretary of Labor, broadly agrees. Although Reich supports the idea of a comprehensive fiscal package, he also thinks that the starting point for any crisis-management policies should be strengthening unemployment measures. Moreover, if an American fiscal stimulus package is rushed through Congress now, it may not be very effective at targeting the problem:

The coming stimulus package... will be voted on by a lame-duck Congress, many of whose members will want to reward campaign donors with juicy pieces of pork. Other lawmakers will see it as their last opportunity to include their pet project or tax perk, and some who won't be accountable because they'll be out of office in a few weeks anyway. In other words, it'll be less a stimulus than a Christmas Tree.

That's something to keep in mind, but there is one thing I do know: strengthening and expanding unemployment benefits isn't as sexy as a massive stimulus package. So, leakage or no leakage, I think we should expect that Christmas Tree to start get decorated a little earlier this year.

(graphs via a Worthwhile Canadian Initiative)

Have Academic Economists Influenced The Bail-Out? Part Deux

I was wrong, Nick was right.

Thank You

The IPE Journal has just passed something of a milestone: over 1,000 unique hits, from over forty-five different countries. All of this in just our third month of blogging - we are humbled. We just want to take a moment to thank all those readers - from Australia to Yemen and everyone in between - for taking the time to stop by and read some of our thoughts on global economic and political affairs. We would also like to thank all those who have provided feedback: positive, constructive, or otherwise.

Below is a map with a pin for every country with a reader that has stumbled across our pages. We hope to add to the map over the next 1,000. Thanks again.


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That Was The Week That Was

Politique
-Asian and European leaders agree to "undertake effective and comprehensive reform of the international monetary and financial systems", presumably at the November 15th G20 summit called by Bush in Washington.

-In his boldest move of a busy week, Sarkozy announced France was creating a sovereign wealth fund to protect national industries from foreign takeover. The slippery slope to protectionism in Europe is being greased.

-US-Iraqi negotiations over Status of Forces Agreement in serious trouble.

-Conflicting signals out of Pakistan: parliament passes resolution condemning "America's war", calling for dialogue with extremists and an end to military action along Afghan border. Within 24 hours, a top military commander claims his forces have seized key village in border region and inflicted heavy casualties on militants, saying "The worst is over...we've turned a corner". Huh...

Economia
-OPEC announces production cut of 1.5 mbd, oil markets shrug it off as crude hits 16-month low.

-Good week/bad week for China: Communist Party leaders approve rural land reform, a giant step towards full rural property rights. China's year-on-year (sorry, Dave) Q3 GDP growth was 9%, its slowest rate in five years.

-Pakistan is in talks with the IMF over an assistance package, joining Hungary and Iceland in returning the troubled institution to relevance. Political power struggle is jeopardizing Ukraine's desperately needed package.

-Currency markets continue extreme volatility. USD and JPY are big winners, with GBP and Euro falling to multi-year lows against the greenback.

The Rest
-India launches first space mission.

-Arsenal manhandles Fenerbahce in Champions League, Spurs sack Juande Ramos and name Pompey's Harry Redknapp new boss, and Hull continues dream start to EPL season.

-Latest 2008 US Election polls

-Finally, the gift that keeps on giving:

Capitalism Will Save Us! Keynes Will Save Us! Greenspan Admits Mistake! & More!

Here are some readables from recent news:

Paul Wells explains that the effort to create a head-of-state-version of the G20 finance minister meetings had long been spearheaded by former Canadian PM Paul Martin. The financial crisis has generously resolved one of the biggest barriers to its creation: what to talk about!

Steve Forbes argues that capitalism will ride to the rescue, picking the ambitious target of next spring for the downturn to reverse itself. Forbes' prediction, which is a little sooner than mine, is likely influenced by two things. First, the inability of the human mind, so focused on the present and recent past, to imagine a prolonged economic downturn. Second, the fact that the cost of being optimistically wrong is small. But if he turns out to be right, oh boy...

Sir Robert Skidelski, the accomplished Keynes biographer, is predictably suggesting that the time is ripe for a new, Keynes-inspired set of theories to deal with current economic developments. I have already explained some of the logic behind using fiscal, rather than monetary, stimulus to kick-start the flagging economy. And in fact, it is probably this Keynes-inspired thinking that has led Fed Chairman Ben Bernanke to endorse a fiscal stimulus package. According to the BBC's Robert Peston, the UK is also considering "a substantial and sustained increase in public spending to offset the contraction of spending by the private sector"

Alan Greenspan admits that he has discovered a flaw in his thinking. Unrelated: a thermometer in hell drops a couple of degrees.

South Africa's deteriorating economy

Over the past few months, IPE Journal has been keeping a close eye on the political turmoil in South Africa. ANC infighting has risked further destabilizing an economy on the wrong side of the global financial crisis. More importantly, South African society is deteriorating from the bottom up, marked by entrenched poverty and inequality, anti-immigrant violence, and a brain drain that undermines the country's progression up the value-added ladder.

The video below is an elegant demonstration of how bad things are getting in Africa's largest economy. I give you Nhlanhla Nene, Chairperson of the Finance Portfolio Committee:



Even the country's infrastructure is crumbling (Zing!)...

Dollar surges to multi-year highs against major currencies

The dollar has hit multi-year highs against major currencies this week. The flight to safety, spurred by the financial crisis and bursting of the commodity bubble, has driven the dollar higher in spite of the ballooning US fiscal deficit.

I have been predicting a strong dollar rebound for the past few months, so the rally is nice for my ego. Unfortunately, I am presently paid in pound sterling.

Dollar denominated debt? Check. Sterling denominated income? Yes. That my friends is a (reverse) currency mismatch. Yay for me.

Is Low Voter Turnout a Bad Thing?

This is a question worth pondering for Americans about to have an election, Canadians who are just recovering from one, and really anyone who has encouraged a reluctant would-be voter to cast a ballot.

Will Wilkinson of the Cato Institute, reflecting on the level of participation in Canada's election (~59%), makes the case that low voter turnout could in fact "signal social solidarity, reflect real civic virtue, and even make democracy work better." How's that? Wilkinson argues that it is not simply your civic duty to vote, but to vote well - as in, voting for politicians that will implement policies that make society better off. Given that many people are largely ignorant of the issues and too busy to research them, abstaining from voting can help to maintain the public good.

But doesn't that mean that, like what I imagine happens at school board meetings, only the people with something to complain about show up? Would that not make elections even more partisan and divisive? Apparently not. According to research quoted in the article, voters of all stripes tend to vote in good faith to promote the public good rather than purely out of economic self-interest. Following this logic, those least able to determine the appropriate policies (re: the uninformed, lazy, or otherwise occupied) should stay home.

Interesting thought. But I would add to this by saying that, even though people think they are voting for the public good, they may not be at all. The classic case is protectionism: "protecting" the country's economy feels like a good idea, but Economics 101 shows how, in most cases, freer trade makes society better off. The academic debate over the value of comparative advantage focuses on the degree of benefit, not the principle itself. Yet despite this, voters consistently vote for protectionist policies. In other words, what voters want and what they vote for are frequently opposites.

I've been reading Bryan Caplan's The Myth of the Rational Voter this past week, and he argues that voters are "rationally irrational." Because the odds of casting a deciding vote in a national election is effectively zero*, it doesn't make sense to spend a lot of time researching the best policies.

"Since delusional political beliefs are free, the voter consumes until he reaches his "satiation point," believing whatever makes him feel best. When a person puts on his voting hat, he does not have to give up practical efficacy in exchange for self-image, because he has no practical efficacy to give up in the first place." (132, original italics)

If you make a bad decision in the marketplace, you pay a price and have an incentive to make better choices. If you make a bad decision in a voting booth, the cost is spread out across the whole population and you have no incentive to make better choices. So, even if Wilkinson is right, voter turnout would have to be minuscule for the effects of rational irrationality to be muted.

This means that, since we're much too fond of our democratic freedoms to restrict voting or have a poll tax, we should expect elections to produce sub-optimal results. And if you're looking for proof, look no further than the latest election coverage.

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*Actually, in the last US Presidential election, each vote impacted the outcome by 0.000000949%.
"Swish that around in your mouth for a while. How does it taste? Taste like freedom? 'Cause to me it tastes like jack-all squat." - Stephen Colbert, America: A Citizen's Guide to Democracy Inaction

Wasteful Ethanol Subsidies & Politics

One of our first posts here at the IPE Journal was on the distorting influence of ethanol subsidies on food prices and their link to naked politicking. Oh, and also on them being a huge waste of taxpayer dollars. Well the FT has just published an article describing the boom-bust cycle of investment into ethanol production - even Bill Gates lost a crop of cash.

Let's also keep in mind that the candidate most likely to win the US Presidency is, to my knowledge, as much in favour of ethanol as the outgoing chief.

George W. Bush Agress With Me!

That's good, right? Right? ...Guys?

The long-run is less important when your bills arrive in the short-run.

On Russia, Part III: US-Russian relations

US-Russian relations are at their lowest point in decades, arguably since the 1960's. While the threat of direct military/nuclear confrontation is remote, the two countries have stopped talking to one another. This is troubling when US-Russian cooperation is critical to solving many of the world's most pressing challenges. Some background:

Vladimir Putin spent his presidency's first term consolidating political power, stabilizing the Russian economy, and seizing control of the country's energy sector. The US took little note. 9/11 and the "war on terror" occupied America domestically and abroad, and Russia was by all accounts a helpful ally. Putin was the first foreign leader to speak with George W. Bush after the terrorist attacks, Russia quietly helped the US prepare for Afghanistan, and it seemed as if the two countries would be natural allies in the post-9/11 world (Russia, after all, has its own terrorism problem).

But a funny little quagmire happened on the way to the party: Iraq. Russia was decidedly against US military expansion in the middle east, and aligned itself with European powers France and Germany against US hegemony. Iraq was the opening Putin needed to shift Russia's foreign policy in contrast to the US, which in retrospect appears to have been his intention all along. In 2005, Putin told the Federal Assembly that the collapse of the Soviet Union was "the greatest geopolitical catastrophe of the twentieth century". Russian rhetoric had turned sharply against the US, and Putin began to present the world an alternative vision to US hegemony.

Iraq, Syria, Iran. On each of these issues, Russia used its voice, influence, and Security Council veto in opposition to US interests. Russia re-asserted its influence over Eastern Europe and the Caucasus through energy leverage and the undermining of democratic movements. This fundamentally clashed with US (and European) policy in the region. Putin's 2007 "Munich speech", in which he lashed out at the US and its "unipolar" project, was years in the making, sharpened by US missile defense plans and prospective NATO expansion, and fed by a punch-drunk confidence derived from petro-dollars and energy leverage in Europe. It marked a new, more hostile, era in US-Russian relations.

Russia's incursion into Georgia was a watershed, with both sides lashing out at the other over those circumstances and, opportunistically, more. The war also convinced the White House that Russia was now a direct threat to US interests. This has resulted in a suspension of almost all communication between the two sides, and a decidedly icy outlook on future relations.

Three angles are important to understanding why this relationship deteriorated, and how it will develop over the coming years:

-one must look at the domestic landscape to understand Russia's foreign policy. Putin's project (political consolidation, economic nationalization, etc.) has relied on/fostered a strong nationalist sentiment within Russia. The creation of external threats is often necessary to build public support in favor of authoritarian consolidation. This works particularly well in Russia, feeding anti-immigrant sentiment, conjuring the emotion over Chechnya, and speaking to a general sense of having been "humiliated" following the collapse of the Soviet Union. Nashi, Kremlin sponsored youth summer camps, and anti-immigrant violence are all expressions of this nationalism. The Kremlin and its surrogates have fostered an image of the US as a country bent on humiliating (post-Soviet collapse), surrounding (NATO), and infiltrating Russian society (opposition groups, critical press, etc.). The perception of an imperial US is shared by Putin, the silvoki, and extreme (well connected) elements of the Russian population. The nationalism the Kremlin has fostered is dangerous, it will prove difficult to put the genie back in the bottle.

-The US appears to have been seriously blind to Russia's methodical build-up since 2001. The war in Georgia seemed to catch US officials completely off-guard. It took weeks for a clear, consistent message to come out of the US government. For an administration populated by so many creatures of the Cold War (not least, Secretary of State Rice, a renowned scholar on the USSR/Russia before joining the Bush administration), it is stunning the US was not better positioned for such events. Sure, missile defense plans have been developed with an eye towards Russia, and US policy in Central Asia is as much about securing Western energy supplies as it is the "war on terror". But the lack of insight into Russian motives and sensitivities demonstrated by the Bush administration is surprising. A final point: for all of the cowboy diplomacy and reckless unilateralism of the first Bush administration, the second term has been defined by genuine multilaterism and pragmatic, realist diplomacy. Whatever the impetus, the Bush administration does not get enough credit for this shift. It is this context that makes the suspension of almost all communication with on America's most important partners so stunning.

-the way forward is unclear. Without dialogue, the two countries risk a dangerous game of chicken, where each side positions itself against the other on critical issues. I strongly disagree with all the talk over a new cold war. It is in neither country's ultimate interest, and circumstances will bind them to a minimum level of cooperation (Russia's financial and economic problems in the current environment, the US need for Russian assistance on Iran). But on significant issues (energy, Afghanistan/Pakistan, financial crisis), they do fundamentally disagree, and a lack of dialogue will undoubtedly lead to confrontation. The importance of regimes in this context cannot be understated.

A working relationship between the US and Russia is critical to solving the energy, financial, political, arms control, and terrorism-related challenges of our time. They should start talking now.

In Defense of Capitalism in the Long Run

My co-author has pointed out that we've become a little too focused on the global financial turmoil of recent months. But before we go back to covering our more diverse range of topics, I want to give some overall impressions.

In short, I think we're in danger of overreacting to dangers facing our economic system. It is now common to hear from our political leadership and media reps that we're facing the greatest financial crisis since the Great Depression. This, in turn, has opened up a lot of space for commentary to the effect that we've let capitalism run away from us, or that our financial system is run by corrupt, greedy, modern-day robber barons that are going to drive our country into the Third World. The gods of the free market have failed and capitalism is in convulsion, declare the pundits.

It is important to recognize that the rhetoric from politicians and mainstream media commentators is as much a reflection of popular opinion as it is an influence upon it. As Bryan Caplan has argued, the general population has an anti-market bias and this crisis has brought it comfortably out into the open.

Two points need to made here. First, this crisis is as much a failure of regulation as of market forces. Second, capitalism has a proven track record of raising our living standards and material well-being, consistently, for the past two centuries. This, often in spite of government failures and broader public sentiment. This is often difficult to see in times of crisis or personal misfortune. Here is Joseph Schumpeter:

Rational recognition of the economic performance of capitalism and of the hopes it holds out for the future would require an almost impossible moral feat by the have-not. That performance stands out only if we take a long-run view; any pro-capitalism argument must rest on long-run considerations.

Well, here is the long run perspective on real income per capita in the US since 1820 (via Chris Blattman):
Except for a blip in the 1930s, there has been steady, consistent growth. Even the Great Depression was not enough to throw off the overall trend. Elsewhere, Caplan has pointed out that in 1800 it took 95 out of 100 Americans to feed the country. Now it takes 3. The success of the market system is undeniable.

Of course, this is being insensitive to the trauma of the 1930s and is no consolation to those who are currently unable to sell their homes or secure a loan for their business. It also fails to recognize the impact of increasingly interconnected global economies that makes unhealthy economies more contagious. So public fury with Wall St. is understandable, but risks being overstated.

The most astute political economists since Adam Smith have recognized the need for government to accommodate for the excesses of the market. Our regulators failed to do this in the mortgage market, and steps need to be taken to remedy this to prevent future crises. But we need not throw the proverbial capitalist baby out with the bathwater.

Luckily, I think our political leaders understand this. As Simon Jenkins has convincingly argued:

The banks have not been "nationalised", just deluged with money. They remain pluralist and competitive institutions, with independent boards. Their workers are not civil servants. Investors retain their shares. The bonus culture will revive. The impresarios of greed have been punished, or at least a few of them. But this is not socialism in our time, just public money hurled at the face of capitalism.

My prediction is that in 12-18 months, the rhetoric of financial armageddon will be a distant memory and people will return to their regular concerns of providing for themselves and their families. That is what the market does best.

Quotable Economics Quotes

"In our seeking for economic and political growth, we all go up - or we all go down."

- Franklin D. Roosevelt

"If all economists were laid end to end, they would not reach a conclusion."

- George Bernard Shaw

On English Food & Intergalactic Trade

Many people have now weighed in on Paul Krugman's Nobel Prize for economics. I just wanted to share two articles he has written that, although not likely contributing to his award, are fun examples of serious economics applied to less-serious topics.

1) Why the British have such terrible food

2) A Theory of Interstellar Trade

Hank "The Hammer" Paulson

While playing football at Dartmouth, Hank Paulson earned the nickname "The Hammer" for his relentlessness. No doubt this was part of the package that helped him rise to the top of Goldman Sachs before moving on to become the US Secretary of the Treasury. Now it seems that The Hammer has been using some pretty blunt tactics to get the latest $250 billion bank recapitalization plan approved by the banks, according to this account at the NYT.

If anyone has any suspicions about whether this bail-out package is a big conspiracy between old Wall St. buddies, this article makes it pretty clear that the government still wears the pants in this relationship.

I wonder how this meeting compares to the one that led major New York banks to prevent the complete implosion of Long Term Capital Management in 1998.

Related Posts:
Politics and the Paulson Plan: A Rant
Weighing the Long Run Consequences
The Week Ahead
Re-thinking the Fiscal Stimulus Approach

Have Academic Economists Influenced The Bail-Out?

That's the question Nick Lembo asks over at Zeitgeist after the most recent proposal to respond to the financial crisis comes much closer to suggestions made by influential academic economists than Henry Paulson's TARP. It's hard to deny that academic economists have had some influence over the debate, but how much?

Personally, I'm skeptical. Once we move past the usual qualifications about correlation and causation, I think it is important to note that these economists have been proposing similar solutions for several weeks now, if not months. Krugman has argued that it was ideology which prevented Paulson from making proposals that would move America closer to a partially-nationalized banking sector, and it took action by the UK to snap them out of it. But the Economists' profile of the Treasury Secretary suggests he is more a pragmatist than an ideologue and that the TARP may have reflected both the realities of Congress and the fact that Paulson simply wanted to be free to take control.

The latest plan is probably an extension of that pragmatism. Policymakers on both sides of the Atlantic are now moving in the spirit of FDR's formula of "bold, persistent experimentation" to deal with economic crisis - albeit belatedly. Gordon Brown, for instance, is a big believer that politics should matter; this was a chance for him to prove it. No doubt the UK's plan - which was emulated by the US and the rest of Europe - was influenced by the government's in-house economists, but it was political leadership that drove it forward.

Moreover, Bernanke appears to have favoured this approach along. He's an accomplished academic in his own right, but, unlike the econ-bloggers, he's on the inside. (I'm also noticing that most of the photographs accompanying articles about the new plan feature Bernanke front and center, with Paulson in the background...).

So what does all this mean for the influence of academics on policy? I think that the explosion of blogs by pre-eminent economists has changed the nature of the policy discussion and has certainly made economic ideas more accessible to the general public. But when it comes to policy, those academics on the outside are going to have settle for, at best, indirect influence.

US Treasury Plans to Part-Nationalize Major Banks

According to the latest crisis measures, the US taxpayer will now own equity in nine major American banks in exchange for a $125 billion capital injection and debt guarantee. Another $125 is expected to be allocated to recapitalize other "healthy" firms across the country.

This decision follows British leadership on the matter, as well as similar European commitments totaling $1.8 trillion.

Gordon Brown has really hit his stride during this crisis. He has reiterated his call for a new Bretton Woods (taking his cue from Rory, of course) to create a new financial architecture for the years ahead. Such calls have been made since the collapse of the "old" Bretton Woods in the early 1970s, but the recent turn of events may very well have convinced enough of the powerful decision-makers that a new approach is required. A "new paradigm," if you will.

We're going to be paying very close attention to any developments of this kind, but one thing I can say with confidence: the G7 is not the venue for such discussions. As a collective decision-maker, the G7 has failed during this crisis - just as it failed to make significant progress in banking and capital market regulation following the Asian crisis in 1997-8. Even today's pledge for collective action amounted to little more than words; the real action was taken elsewhere. These meetings are geared towards discussion, not decisions. Even the expanded G20 fails to effectively include all the significant players in today's global markets.

If we want to see results, we need to leave this old boys club behind.

Paul Krugman wins Nobel Prize in economics

Princeton University professor, New York Times columnist, unabashed liberal and giant of the economics profession Paul Krugman has won the Nobel Prize in Economic Sciences for "his analysis of trade patterns and location of economic activity". This stems from his development of "new trade theory" and "new economic geography".

The FT has a good, brief summary of these theories here.

Any student of IPE, economics, IR, or finance knows Krugman well, and this recognition will come as no surprise. What did surprise me was the Nobel committee's reference to his status as an "opinion maker". This can be interpreted in two ways: as a reference to his popular status, prolific writing, and persuasive arguments, or to his very partisan political commentary. Given the politicized climate surrounding Al Gore's award, it is odd that the committee would allude to Krugman's political views, especially just weeks before a presidential election in which he has been a very vocal critic of one of the candidates (you can guess which one).

I am not one of these disingenuous Nobel purists who believes that prizes should only be awarded strictly on intellectual merit (these criticisms usually come from political critics of the individual winners, not defenders of the integrity of the prize itself). I do, however, worry that by referencing this aspect of Krugman's work, it provides the context for Krugman's political critics (cue Bill O'Reilly) to undermine his achievement. Krugman is highly deserving of the prize, and his political views shouldn't cloud any recognition of his important and groundbreaking research.

We are living through a period in which thoughtful defenders of free trade (tempered, in Krugman's case) and instructors on the complexity of globalization are largely absent in the popular discourse. This is why Krugman's ability to explain complex economic and political trends in layman's terms is so important. This is probably what the committee meant by the phrase "opinion maker". However, some will ascribe a political element to this award, or be unwilling to separate his political commentary from his economic scholarship, and that is unfortunate.
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Case in point: even Reuters can't separate the two Krugmans.

UPDATE: Donald Luskin initiates the backlash. This is one prediction I am disappointed to have been right on. (Via FP Passport)

UPDATE2: the FT is totally plagiarizing me! Shameful, pink lady...

That Was The Week That Was

Economia
-Global stock markets crash. For the week: Dow -18.2%, FTSE -21.0%, Nikkei -24.3%, Hang Seng (Hong Kong) -16.3%, Jakarta -21.0%, Moscow -19.0%. Trading was suspended multiple times in emerging markets from Indonesia to Russia.

-Some perspective from the FT: at its low point yesterday, Dow was -23.64% for the week. During the crash of 1929, Dow's lowest weekly point was -23.62%.

-US oil futures fall to lowest level since October 2007. IEA forecasts slowest global demand growth in 15 years. OPEC calls emergency meeting, with oil approaching their perceived price floor of $80 a barrel.

-Extreme volatility in the global currency markets. Flight to safety boosts USD and JPY, commodity currencies like AUSD and NZD plunge. If you own Icelandic krona, buy a furnace.

Politique
-As global markets burn, G8 leaders squirm. Utter lack of coordination, mixed messages, and Berlusconi's insanity compound financial turmoil.

-UK government announces 400bn pound bail-out; effective partial nationalization of entire banking sector marks most decisive action to date by major financial power.

-IMF announces emergency lending facility for emerging market borrowers, first since Asian financial crisis. Proclaims "decoupling" theory rubbish.

-Ukraine's president Viktor Yushchenko dissolves parliament following (final?) collapse of ruling coalition. Power struggle ensues.

The Rest
-Martti Ahtisaari, former president of Finland, wins Nobel Peace Prize "for his important efforts, on several continents and over more than three decades, to resolve international conflicts".

-Major European countries, including France and Germany, call for easing of EU climate targets in light of eurozone recession.

-UEFA president, and epic blowhard, Michel Platini targets England's football clubs over debt and foreign ownership, threatens exclusion from Champion's League. Big-4 clubs laugh, dominate Champions League again.

-As if traders hadn't lost enough, CNBC reporter Rick Santelli finds this on the floor of the Chicago Board of Trade.

-Monkey waiters hit Japan. Japan becomes greatest place on earth, tops Rory's bucket list.

-Latest 2008 US election, Canadian election numbers.

Friday

Well, it's Friday. And rather than getting all worked up about the fact that the markets are dropping everywhere in the world and traders are sorely in need of a giant canoe-paddle to the face, I'm going to focus on some lighter fare.

Here is a little chart produced by Jessica Hagy, the wonderfully creative mind behind Indexed, that sums things up rather nicely. (Reproduced entirely without permission. Apologies, Jessica).

Cliff diving

This week's cover of The Economist:

Snapshot of the Dow:

That drop at the end is us falling off the cliff.

U.S. National Debt Clock is broken

Anyone who has lived in or visited New York City will recognize the massive "National Debt Clock" towering above the corner of 43rd and 6th. A constantly spinning reminder of our reckless spending and negative savings rate, the Clock was created in 1989 by New York real estate developer Seymour Durst to highlight America's debt burden.

Well, folks, the clock broke yesterday, having finally reached its limit of $10 trillion.

A temporary adjustment has been made that will allow the clock to keep counting. Lucky us...

The Morning FT Round-up

The Financial Times is easily one of the best English-language newspapers out there. I used to consider the pink paper the symbol of snotty, umbrella-toting bankers in the Square Mile, but it's a reliable source of quality material on all things international political economy. Here's a selection from today:

Asia's Revenge - Martin Wolf points to the depressing similarities between this crisis and the various other financial crises of the past three decades. Wolf moves away from the specific day-to-day details to provide a broader historical perspective on the trends that led to our current situation. He then draws conclusions about the relationship between liberal capital markets and the global economy. This is a must-read.

Banks Face a Regulatory Revolution - although talking specifically about banks in the UK, this applies to both sides of the Atlantic and the English Channel. The article does a better job of arguing what I was getting at below: namely, that more regulation is required, but "cowing the financial sector utterly and turning its members into mere regulated utilities... would extinguish one future motor of national economic growth at a stroke."

India Cannot Afford To Delay Banking Reform - In the reverse of the situation in the UK and US, reform in India has come to a screeching halt as the anti-reform members of the ruling coalition have been strengthened by the apparent implosion of Anglo-Saxon capitalism (the Anglo-Saxon model forms the basis of many of the banking sectors' "best practices.")

The broader Indian population is right to be more cautious about opening up its banking sector to global markets before it is strong enough - East Asia learned that lesson already. But if the author is correct, and large areas of India are starved of capital, then the further growth of the Indian economy is being held back. And although the debate over how to properly sequence banking reforms is ongoing, this is not likely a step in the right direction.

Subprime Mortgages & Risk Sensitivity Explained

"It is sad how little we have learned about the market’s frequent insensitivity to risk."

That's the concluding sentence of a short essay by Avinash Persaud that helps to explain why sub-prime mortgages, which account for less than 1% of the world's debt, caused this whole mess:

The pursuit of “risk sensitivity” led to a re-organisation of bank assets away from lending on the basis of the banker’s private views about the borrower - regulators considered this hard to quantify and a little suspect – towards lending on the basis of an external credit rating. The higher the rating, the lower the capital banks had to set aside against the loan. Regulators saw this as not only risk-sensitive but transparent and quantifiable. Banking by numbers was oh so modern.

Regulators always seem to be pushing towards greater transparency in all things. Transparency is, in itself, a good thing - no question. But I find the total and complete focus on transparency to place too much faith in the ability and/or willingness of market actors to understand what these indicators reveal (or don't) and to alter their behaviour accordingly. In this case, the article concludes that the push for quantifiable risk actually obscured the nature of the risk within debt instruments.

For the policy discussion at hand, this is part of a larger point on regulation. Last night we heard Senator Obama blaming "deregulation" for the current crisis, and it's reasonable to expect the regulatory hand to come down a lot more heavily in the months to come. So be it. But preventing future bubbles in non-mortgage-related markets will require better regulation, not simply more of it. This is, of course, easier said than done - but I think it's time to take a good hard look at the market's historical record in sensitivity to risk.

Thabo Mbeki: From One Crumbling Government To Another

Poor Thabo Mbeki. The guy just can't catch a break. After being replaced as head of the ruling African National Congress (ANC) last December by his rival Jacob Zuma, Mbeki was forced to step down as President of South Africa last month - about six months before his term expired.

Still in demand as an influential statesman, however, Mbeki was asked to help negotiate the power-sharing arrangment in Zimbabwe between President Robert Mugabe and the head of the Movement for Democratic Change (MDC), Morgan Tsvangirai. Now it appears that this deal is close to collapse - albeit through no fault of Mbeki's.

In an unfortunate twist, even as Mbeki is supervising the collapse of a neighbour's, er, "government," his home country is facing the very same prospect. South Africa's former defence minister has served the divorce papers to the ANC, likely instigating a split in the party and the creation of a breakaway rival party. As Rory explained earlier, this divorce has been a long time coming - nevertheless, with Presidential elections not scheduled until April, this leaves South Africa vulnerable in a period of political and economic uncertainty.

Meanwhile, the hapless Mbeki is now closely associated with the crumbling of two African governments in less than a month - I wonder if the leaders of the other AU countries are still returning his calls...

George W. Bush: IPE Journal reader?

I am happy to report that my call yesterday for a coordinated, global response to the financial crisis has been heeded by the most powerful lame-duck in the world...

NYC mayor Michael Bloomberg agrees...

and even the Europeans are warming to the idea.

In all seriousness, this official realization is an important development, and will hopefully lead to concrete policies and principles.

As we fall deeper into the "abyss"...

We all hoped that the signing of the Paulson Plan on Friday would bring some calm and mild confidence back to the global markets today. But as The Telegraph proclaims, we appear to be free falling into an "abyss". While the article's focus on monetary policy (as accelerating the crisis) is, in my opinion, missing the point (I have long said, however, that Greenspan's Fed created this mess more than any single actor), it does reiterate something I briefly touched upon a few days back: the staggering lack of coordination between governments has been a decisive factor in the contagion spreading across the globe.

Europe and Asia are rapidly catching up to the US (it was thought just a few months back that these two regions were well placed to weather the storm). Emerging markets are losing capital fast, and Russian authorities have resorted to simply shutting down the market every other day to stem losses.

All the while, a common, global strategy has been missing (with the exception of central bank liquidity injections). We urgently need a Bretton-Woods style conference to produce a massive, coordinated response to this crisis. The international financial and economic architecture must be reconfigured in line with 21st century markets and power, and the current crisis has highlighted the urgency with which this must be addressed. Europe's lack of coordination is proving more disastrous by the minute. Let us stop the global deterioration now.

Deeper Causes

One of the side-effects of the current financial crisis is that people have stopped to reflect on some of the less obvious, underlying and long-run reasons for our predicament. Or perhaps they've been doing it all along and it's only now that we're paying close attention.

First, Robert Feinman (via Mark Thoma) on Democracy:

Even the wisest of governments can vote itself into a future disaster if it wishes to. The real culprits in this collapse are us, the US public....

For several decades the public has been pushed into investing in the stock market. The secure retirement funds have been eliminated and they had no choice. Even those with traditional plans have been encouraged to do further investment using IRA's and other vehicles. The nightly business news hypes new stocks every day and people tend to believe that 10-30% returns are to be expected.

In this atmosphere any firm which doesn't engage in risky behavior soon sees it stock in disfavor and it CEO bounced out by Wall Street types who want to "unlock the potential" of the firm.

As Pogo said: "We have met the enemy and he is us".

If we had a stable society where people were assured that their old age would be funded and that illnesses would not bankrupt them and their families then appeals to such speculation would not be so inviting. German's put a quarter as much of their earnings into stocks as do Americans. They prefer banks. The fact that they have much better social services means they can go for low risk investments.

So, no, there is no way to prevent another bubble-crash cycle in the US as long as the social structure and financial incentives remain as they are

Do you think this assessment is correct? On a side note, Germany's relative financial prudence has not insulated them from the negative economic effects of the crisis.

Second, Professional Economists: we can forgive Gavin Kennedy's run-on-sentences for bringing us this piece. Citing David Warsh, Kennedy suggests that

...the economics profession, as trained in the past thirty years, is not treated to any passing familiarity with the nature and causes of ‘the cycles of manias, panics and crashe[s] that have been a familiar feature of global capitalism since its emergence in the seventeenth century’. Indeed... leading introductory textbooks scarcely mention them.

Now that I think about it, I wasn't introduced to the idea of a business/credit cycle in my undergrad economics courses - a concept that was understandably central to the work of Keynes, Hayek, and other Depression-era economic theorists. According to Warsh's essay, this trend may be changing very soon.

Liberal and Conservative Party Platforms: Int'l Perspective, part II: Environment

I have been patiently waiting for the release of the Conservative party platform to continue with this series on the election issues in Canada from an international perspective, but it appears that I am waiting in vain. It's shocking that a party can run for re-election without a platform, but so be it. All I can say is that, given the popularity of part 1, even as the media focuses on the personality-cult of election campaigns, people are actively searching out the positions of the political parties on their own - that's encouraging.

So today I will be looking at the Liberal and Conservative positions on the environment & taxation - specifically, how each party plans to spread the cost of meeting emissions targets. Taxation and environmental policies are crucial both for Canada's economic competitiveness in attracting foreign investment and rebuilding its moral authority at multilateral negotiations. Also, regardless of which plan is implemented, it will serve as an important model for other countries to study, for better or worse.

The Conservatives
The Conservatives' environmental plan amounts to a cap-and-trade system. Andrew Coyne has an excellent summary of the plan here. Emissions are "capped" at a certain level; firms that cut emissions below the cap can earn credits on the surplus; firms that exceed the cap must buy up credits from the surplus market. Alternatively, firms buy credits on the international market or contribute to a "green technology fund."

The goal is to reduce emissions by 20% by 2020, using 2006 as the baseline. Make no mistake, said Stephen Harper in 2007, this regulatory framework will create "very real costs" and result in "noticeable price increases for consumer products such as vehicles, natural gas, electricity, and household appliances." As Coyne rightly points out, we're not hearing much about those costs anymore.

The Liberals
In a nutshell, the Grits' Green Shift amounts to a carbon tax: greenhouse gas (GHG) emissions will be priced at $10/tonne, rising another $10/year until it reaches $40/tonne. To offset this carbon tax, the Liberals promise to cut income taxes for the lowest bracket from 15 to 13.5%, and the income taxes of the middle brackets from 22% and 26% to 21% and 25%, respectively. Small businesses get an additional 1% cut, and there will be further undefined incentives for green technology.

The Liberal target is also a 20% reduction by 2020, but they're using 1990 as the benchmark - so, a more ambitious target.

Analysis
As LSE's own maver-economist, Willem Buiter, points out: from an economic perspective, a cap-and-trade system is equivalent to a carbon tax. Both a market cap and a carbon tax raise the marginal cost of GHG emissions. Those with a low marginal cost will expand their activities, those with a high marginal cost will reduce them. The biggest difference is that, under a carbon tax, the price of carbon is set at X and firms trade amongst themselves. Under a cap & trade, the total amount of emissions is set, permits are auctioned off, the secondary market establishes a price, and the firms trade amongst themselves.

However, Buiter qualifies the equivalence:

An argument in favour of carbon taxes over cap & trade is that cap & trade requires an efficient secondary market. As we know from recent experience, financial market efficiency cannot be taken for granted.... In a world with uncertainty but incomplete markets, the carbon tax and cap & trade are similar but not equivalent; neither one obviously dominates the other under all circumstances.

The main trade-off is knowing the price of carbon vs. knowing the amount of GHG emissions. From a business perspective, I would imagine the prospect of a tax is discouraging, but the certainty of the costs allows for more accurate business modeling. On the other hand, the cap-and-trade system is more obscure than a tax, which makes it popular for politicians.

In both cases, revenue is generated for the government that can be used or abused as they see fit. I will finish by summarizing Andrew Coyne's analysis, which neatly outlines the flaws in both plans.

Conservatives

• The plan is "just as costly as the Liberals'... twice as complicated...and probably half as effective." Indeed, leading climate experts agree that even the modest targets set by the Tories will not be met.
• Ironically, given the Conservatives' 2006 platform, the cap & trade is less transparent than the carbon tax
• The plan is infinitely less politically risky than the Liberals', which also makes it more likely to be implemented

Liberals

• The plan is not radical enough, but costly enough to annoy everyone.
• Libs haven't explained how they will apply the carbon tax to provinces that already have one, and have not promised to cut income taxes by anything near enough to make this revenue neutral, as promised.
• The details are fuzzy, and a tax is politically unpalatable, making its implementation (especially in a minority government situation) far less likely.

Post-debate analysis

It amazes me how such diminished expectations can lead pundits to characterize Sarah Palin's performance in the vice-presidential debate as strong. But hey, she's just a maverick.

And who is "McClellan" anyway? He certainly isn't the commander of US or NATO forces in Afghanistan...you could tell Biden was biting a hole through his tongue on that one.

Next 3am phone call:

Vice-President's office: (ring, ring, ring)...hello?
Wasilla, Alaska: Mr. Vice-President, sorry to bother you at such an early hour.
Vice-President's office: no problem Governor, I'm up playing Bomb Iran 3000, its the coolest game, have you played it?
Wasilla, Alaska: doggonit sir, you know, i haven't. Iran, huh, that's next to Texas, right?
Vice-President's office: (sigh)...what can I do for you, Sarah?
Wasilla, Alaska: golly Mr. Cheney, I was thinking of a way to expand the powers of the vice-presidency, you know, over the senate and constitutional flexibility and i'm a maverick and things of that nature...whats your secret?
Vice-President's office: its classified.
Wasilla, Alaska: you mean like those tiny little ads in the back of the Frontiersman?
Vice-President's office: (sigh)...you just leave that up to me, Governor. One can attach a lot of signing statements to a bill as big as the bailout.
Wasilla, Alaska: thanks Dick. off to shoot wolves out of a helicopter...
Vice-President's office: go get 'em tiger.
Wasilla, Alaska: you betcha!
------
I know, maybe a little harsh. But true, no?

(Photo: AP)

Some thoughts on the financial crisis

A few thoughts on the financial crisis:

-Europe's fractured response to the crisis is a snapshot of why the Euro's viability as a new primary reserve currency is weak. Uncoordinated and competing regulatory/financial authorities across the bloc undermine the short to medium term confidence in the common currency. As Peter Garnham notes in the FT today, investors are questioning the ability of European governments to respond to the spreading crisis in a coordinated manner. On Tuesday, this lack of confidence led the Euro to its largest one-day decline against the USD since 2001.

-Wake up America, higher taxes are on the way. Period.

-While I believe that, as imperfect as it may be, the Emergency Economic Stabilization Act of 2008 (Paulson Plan) is needed to prevent a total global economic meltdown, there is something oddly pleasing about the House's rejection of the plan. The majority of Americans are against the bailout plan, specifically the notion of bailing out Wall Street while mortgage relief for the average citizen is resisted and bankruptcy laws that are perversely skewed in favor of creditors (yes, those same creditors) remain unamended. Now, the last thing elected representatives should do in a time of crisis is pander to the emotions of their constituents, or make decisions on the basis of electoral considerations (which, by the way, is the primary Republican impetus for voting "no"). Controversial, unpopular policies are sometimes necessary, and the Paulson Plan is undoubtedly one of those. But a "no" vote does seem to reflect the genuine sentiment of the American people, and at the very least has bought some time to include the much-needed (in my opinion) individual mortgage relief and bankruptcy changes.

-Finally, GWB's televised address to the US people last Wednesday was pretty unremarkable, and the choice to stand in the same doorway as he did on the eve of the Iraq war did little to boost his credibility. But one passage struck me as truly powerful in both context and significance. For the first time in my life, I listened to an American president defend free market capitalism. Not promote it, or highlight its virtues relative to an alternative model, but actually defend its very existence. He said:

"Despite corrections in the marketplace and instances of abuse, democratic capitalism is the best system ever devised. It has unleashed the talents and the productivity and entrepreneurial spirit of our citizens. It has made this country the best place in the world to invest and do business. And it gives our economy the flexibility and resilience to absorb shocks, adjust, and bounce back."

On this topic he is, and it is strange to say this given the messenger...both eloquent and correct. In the past few weeks, the "anglo-saxon" capitalist model has come under fierce rhetorical attack, especially from Germany, Russia, and of course France. To this point, France and its banking sector have weathered the storm perhaps better than any major western power. Sarkozy has called for an international conference, a la Bretton Woods, to construct a new "regulated capitalism".

Surely, unfettered finance and blanket deregulation have produced disastrous consequences for the global economy. Even the massive wealth creation they have facilitated is problematic, with income inequality rising across the western world. "Re-regulation" is desperately needed, and, in my opinion, beneficial in the long run. But the free market is still the best, worst option we have (to channel Churchill). It has brought more individuals out of poverty than any system in history, and it is the most flexible, dynamic economic model the world has ever seen. Despite the current political and financial climate, it is not a zero-sum game.

We are undoubtedly heading "towards a new paradigm on global markets and authority", and this is good. But let us not abandon capitalism just yet.

US Senate Agrees To Toxic Assets Deal

Late yesterday, the US Congress voted 83-13 in favour of a deal that will bring about a new era in the way in which dangerous assets are traded and governed.

With India.

What's that? You thought I was talking about the bail-out package? Not this time.

While the media devoted it's almost complete attention to the credit-crisis shenanigans, the US Senate quietly put the final stamp of approval on a nuclear deal with India that undermines the nuclear non-proliferation treaty, the comprehensive test ban treaty, and the credibility of the US negotiating position with Iran and North Korea. More to come shortly.

September Madness

Financial Crisis Fantasy Pool, (via Matt Yglesias)

I'm personally hoping for a final match-up between the Queen of England and the US Federal Reserve.

Interactive version here.

Caution: landslide ahead

Dave's recent coverage/analysis of the financial crisis and debate over the Paulson plan has been excellent (here and here and here...where do I stop?). The political, financial, and economic implications of the current turmoil are all colliding, leaving much uncertainty in the markets and halls of government.

One development, however, seems to be crystallizing by the day: Americans are running to Barack Obama. The RCP national average has Obama with a 5-point lead, a dramatic reversal from the immediate weeks after the Republican national convention. Students of US politics will know that national polls are nothing but a barometer of the electorate's mood, and in the end mean very little. The electoral college is the bread and butter of US presidential elections, and by this measure Obama is on course for one of the largest landslides in decades.

According to RCP, Obama would win the election today by an electoral count of 353 to McCain's 185, a 168 vote advantage (including toss up states- those below a 2% margin of error). Just two weeks ago, Obama held a narrow 12 vote lead. He is also just 23 electoral votes away from victory in the "got this state on lock" column.

Obama's numbers have surged dramatically in battleground states like Ohio, Florida, Virginia (Virginia!), and Indiana (Indiana!). He has opened up a 7.7% lead in the key state of Pennsylvania, and has essentially finished off Michigan and Colorado.

The reasons for Obama's remarkable surge can be summed up in two words: the economy (there is no shortage of good analysis on this). Absent a game-changer over the next month (how many Palins can McCain pull out of his hat?), or Obama showing up nude to the next debate, it is difficult to see how the democratic candidate does not win this election. The only question now might be: by how much?